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New evidence that individuals do not make sensible health insurance decisions

Do Individuals Make Sensible Health Insurance Decisions? Evidence from a Menu with Dominated Options

By Saurabh Bhargava, George Loewenstein, and Justin Sydnor
National Bureau of Economic Research, NBER Working Paper No. 21160, May 2015

Abstract 

The recent expansion of health-plan choice has been touted as increasing competition and enabling people to choose plans that fit their needs. This study provides new evidence challenging these proposed benefits of expanded health-insurance choice. We examine health-insurance decisions of employees at a large U.S. firm where a new plan menu included a large share of financially dominated options. This menu offers a unique litmus test for evaluating choice quality since standard risk preferences and beliefs about one’s health cannot rationalize enrollment into the dominated plans. We find that a majority of employees – and in particular, older workers, women, and low earners – chose dominated options, resulting in substantial excess spending. Most employees would have fared better had they instead been enrolled in the single actuarially-best plan. In follow-up hypothetical-choice experiments, we observe similar choices despite far simpler menus. We find these choices reflect a severe deficit in health insurance literacy and naïve considerations of health risk and price, rather than a sensible comparison of plan value. Our results challenge the standard practice of inferring risk attitudes and assessing welfare from insurance choices, and raise doubts whether recent health reforms will deliver their promised benefits.

Conclusion

Our principle contribution is to document widespread and costly violations of dominance in the health-insurance decisions of a large and diverse sample of U.S. employees. Unlike most prior work, our paper is able to transparently assess choice quality without making assumptions about risk preferences or beliefs, by analyzing employee choice from a standardized plan menu with a large share of financially dominated options. For the majority of employees who chose dominated plans—a disproportionate share of whom were of low income—the adverse financial consequences of poor choice outweigh the estimated benefits of recent policy measures (e.g., the effect of the exchange on insurance premiums, or the penalty associated with the individual mandate) that have attracted far more policy attention.

Our initial results prompted us to address the question of why employees make such disadvantageous decisions. Through a series of online experiments with hypothetical choices modeled on the firm’s plan menu, we find evidence for a modest role of search/menu complexity and much larger role of low health literacy. Confirming other research, we find widespread deficits in employee understanding of the insurance choices they face. Even with simple menus with few options, we observed significant errors in plan choice, suggesting that plan choice is difficult to improve. The online studies suggest that poor choice may partly reflect a heuristic understanding of health insurance such that consumers sort into plans based on perceived health risk and inferences about plan generosity from the rank-ordering of plan deductibles rather than a careful assessment of financial plan value.

The promise of recent reforms that expand choice and aim to increase provider competition is premised on the assumption—challenged by our research—that enrollees will make sensible plan choices. While efforts to improve choice through simplification, education, and other modifications to the choice environment may improve the quality of decisions, our results suggest value in shifting focus from helping consumers navigate complicated insurance options to simplifying and standardizing the options themselves. At the extreme, if all firms offered identical products, then competition would be far more likely to focus exclusively on price and quality. Beyond implications for policy, our study asserts that traditional attempts to infer risk preferences from health insurance choices may be misguided. Rather than reflecting rational deliberations involving cost, need, and risk, many health plan choices likely reflect heuristic choice strategies grounded in a fundamental deficit of health plan literacy.

http://www.nber.org/papers/w21160

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Comment:

By Don McCanne, MD

Regarding whether or not individuals make sensible decisions when purchasing health insurance, these authors conclude, “many health plan choices likely reflect heuristic choice strategies grounded in a fundamental deficit of health plan literacy.” That is, individuals do not understand health plan options well enough to make sensible choices on their own.

So much for the political campaign that led to the Affordable Care Act - you remember, the campaign that called for CHOICE, when by choice they meant choosing exactly the health insurance you want. As the authors state, “We find these choices reflect a severe deficit in health insurance literacy and naïve considerations of health risk and price, rather than a sensible comparison of plan value.” This raises “doubts whether recent health reforms will deliver their promised benefits.”

The authors further state, “At the extreme, if all firms offered identical products, then competition would be far more likely to focus exclusively on price and quality.”

But we can go them one better. Suppose we had one identical comprehensive product for everyone, and removed price as an issue by funding care through an equitably-funded, universal risk pool. Then we would all get the care we need, and select our care based on quality.

It may be that the perception of quality would be based on “heuristic choice strategies” with a “deficit of health (quality) literacy,” but limiting decision options to only that of perceived quality, whether or not the perception is valid, would result in a vastly superior concept of choice than that which applies to the health plan marketplace - whether the individual insurance market, the ACA exchanges, employer-sponsored plans, or Medicare Advantage and Part D plans.

Obviously, under a single-payer improved Medicare for all, the only choice that we would have to make would be our health care professionals and institutions, and that choice would be based on perceived quality - a much better deal for us all.